As the Supreme Court prepares to hear oral arguments in the highly anticipated South Dakota v. Wayfair, many states are passing legislation directed at putting sales tax obligations on remote sellers.
What’s Up With Wayfair
Currently, the standard for when a retailer has nexus with a state, allowing the state to require the retailer to collect sales tax on their sales in the state, is one of “sufficient physical presence.” This standard has been in place for decades, most recently upheld by the U.S. Supreme Court in the 1992 Quill decision.
However, after passing a law establishing a different nexus standard (called “economic” nexus — more on that below), South Dakota is due to argue before the Court in April that the retail market has changed dramatically enough with the advent of eCommerce that Quill’s physical presence standard is out of date.
The issue of when a state can obligate a retailer to collect sales tax — and in particular how the current standard bars them from doing so with most remote sellers — has reached a critical point. It is estimated that states are losing billions of dollars in missing tax revenue from untaxed sales over the internet. While a ruling in favor of South Dakota in Wayfair would do a great deal to shift the debate, many states are getting in ahead of the Court and passing bills establishing economic nexus rules and notice-and-report requirements (again, more on these below).
How Are States Preparing?
A quick look at legislative calendars will reveal dozens of proposed bills from many more states — a full review would be ungainly, if not impossible. Instead here are some highlights:
Idaho is poised to pass a bill imposing sales tax obligations on remote sellers. If approved, the bill would require remote sellers that make more than $10,000 worth of sales in a year to either collect and remit sales tax on their sales to the state, or send regular notices to their Idaho customers reminding them to pay use tax.
Nebraska had a similar bill that was poised to pass over the veto of the state’s governor. However, in a late breaking event, the bill failed to overcome a filibuster in the state’s legislature. Instead, opponents of the bill advocated waiting until the Wayfair decision comes down to act.
While less progressed than Idaho or Nebraska, states from Georgia to Illinois to Hawaii to Kansas also have bills pending that would obligate remote sellers to become sales tax collectors, or fulfill notice and report requirements.
And that is only in upcoming legislation; the map is rather full when it comes to existing such bills.
What Have States Already Done?
Economic Nexus: Roughly a dozen states currently have rules that establish an economic threshold as their nexus standard. “Nexus” is a bit of an amorphous phrase, which generally means a condition where a business has enough ties to the state whereby the state can regulate it. “Physical presence” nexus, then, establish that those ties relate to actual, physical contact between the state and the business; this includes things like having property in the state, having employees in the state, and using in-state services to support the business.
“Economic” nexus, instead, would establish a threshold of money transfer as that necessary connection. In the states that have passed such bills, this threshold is fairly high, on the order of $100,000, $250,000, or $500,000 in annual sales to the state (the amount varies among each state).
Now, at present, economic nexus is not valid law. Under the still-governing Quill ruling, the Supreme Court determined that only a direct physical connection to a state would permit that state to impose sales tax obligations (though how “direct” that connection needs to be has been contested over the years, notably with the establishment of click-through nexus a few years ago).
Until Quill is overturned, either by Congress or a new decision by the Court, it is the law of the land. As such, even though many states have economic nexus laws on their books, they are unenforceable, and subject to contest by businesses. (And indeed, South Dakota’s bill is being contested in Wayfair.)
Notice-and-Reporting: The first thing that should be said about “notice-and-reporting” requirements, is that they are not a requirement to collect sales tax. Indeed, that fact was central to the series of court rulings that validated notice-and-reporting as legal.
Notice-and-reporting requirements follow from a state’s use tax obligations. Use tax is an ancillary of sales tax (the two are usually mentioned in the same breath), and is required to be paid by the user of a good or service when sales tax was not collected at the time of purchase. Technically, this means that remote sales are never tax-free; if the seller does not collect sales tax, because they don’t have physical nexus and therefore cannot be obligated to collect, then the purchaser is supposed to come back and remit to the state what it is due.
But, whether out of ignorance or avarice, use tax is almost never paid, and so remote sales have the reputation of being tax-free. To combat this non-payment, states are establishing notice-and-report requirements.
Under these rules, the remote seller — if they do not just go ahead and become a sales tax collector — is charged with sending out notices with each of their orders reminding their customers that the customer is supposed to pay use tax with their annual state income tax. In addition, the remote sellers must send a report to the state regulators indicating which residents they should expect use tax payments from.
While new, these notice-and-report requirements can be a heavy (and potentially embarrassing) burden to fulfill. So much so that just becoming a sales tax collector could be the better path.
Colorado was the first state to establish a notice-and-report rule, which became effective in 2017 after an extended legal battle. Since then, about a dozen states have passed similar rules, with more in the prospect.
Recent states actions requesting data from Amazon regarding their online sellers (particularly Rhode Island’s in February) may have something to do with these notice-and-report, and other expanded nexus rules. The states want to know who all is selling to their residents, so they know who to expect tax reports, and even tax payments, from.
There is a tremendous amount of uncertainty around sales tax and remote sellers. How Wayfair may turn out, the next years could be extremely different for online sellers when it comes to their sales tax obligations. Whatever does happen, it is almost certain that states will do everything they can to ensure they receive as much tax revenue as they feel is due.
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